Expansion and Contraction of Credit.—This it does by expanding and contracting the volume of credit and by varying its price. It expands credit by making advances and buying securities, so giving the power to those who borrow from it or sell to it to draw cheques which they can pay into their banks, or to take notes from it which they can put into circulation or turn into gold for purposes of export ; it contracts credit by selling securities or by borrowing in the market from the discount houses and other large dealers in money and it regulates the price by raising or lowering its rate of discount, at which it buys bills of exchange, and its rate for advances, which is usually 1% higher. By making changes in its official rate it affects the general price of credit throughout the country, because the other banks base on Bank rate the rates that they allow to depositors (subject to the bargaining power of the depositor) and the rates at which they make advances to their borrowing customers. The effect of a rise in bank rate thus makes credit dearer to all who are engaged in business and so tends to induce them to reduce their commitments by selling commodities that they are carrying on borrowed money; a lower level of prices is thus produced which stimulates exports and reduces imports and tends to turn the foreign exchanges in favour of London and to check demands on its gold stock, to protect which a rise in bank rate is usually designed. By these methods the central banks of the countries which have currencies based on gold, work to maintain the value of the national money as measured in those of other countries and so give to international trade the immeasurable blessing of comparatively stable rates of exchange, which is the chief justification of the gold standard, in spite of the obvious drawbacks to which its critics can point. It is true that gold, ow ing to the large fluctuations in its rate of output has failed, in the past, to provide the world with a stable measure of value; but the use of the gold standard by the chief commercial countries of the world knit all their currencies together by means of the gold link, made price movements in all of them more or less uniform, and prevented the wild fluctuations in exchange which made foreign trade a gamble during the after-war period, when the gold stand ard was for the time being abandoned. It may also be hoped that closer co-operation between central banks and a more conscious and general effort towards the stabilization of prices will produce greater stability in spite of fluctuations in the output of gold, until the time arrives when the world is sufficiently civilized to be able to adopt an international paper currency.
When credit has to be expanded, owing to seasonal demands such as occur regularly at the end of June and still more at the end of December, a large business is usually done by the Bank of England in discounts and advances, the other parties to the trans action being generally the discount houses. It is not usual in Eng land for the banks to borrow directly from the central bank— they keep habitually a large amount of money lent, from day to day or for a week, to the discount houses and when they wish to reinforce their holding of cash, they call in part of these funds from the latter, who are thus obliged, if the process goes far enough, to borrow from the Bank of England, either by taking bills to it for discount, or by applying to it for advances. By this method, new credit is created by the Bank of England which is paid in by the discount houses to their banks and increases the latter's holding of "cash at the Bank of England." The Provision of the Means of Payment.—On the basis of the credit provided, or the notes issued, by the central bank, the other banks in countries such as America and England, with a developed banking system, provide the community with the de posits which are potential money, because they confer on their owners the right to, draw the cheques, by which the immense ma jority of commercial transactions are settled. The central bank
issues notes and creates deposits with an eye on the relation be tween its gold and its liabilities in the form of notes and deposits outstanding. In America a proportion is fixed by law which has to be maintained by the bank subject to the possible payment of a tax. In England there is no law about the amount of deposits that the bank may have in relation to gold reserves, but all notes above a hard and fast line have to be backed by gold. There is much to be said in favour of both systems, and the one adopted in America is generally approved and adopted in other countries; but the difference between them is largely formal and is not nearly so important as the skill and prudence with which the system is handled by those in charge of it. The notes issued by the central bank except the American Federal reserve notes are "legal tender" —that is, have to be accepted by creditors in payment of debts. (In England Treasury notes are legal tender, but it may be hoped that by the time these words are published, this war-time excre scence on the British monetary system will have been abolished, and the Treasury notes fused with the Bank of England's note issue). The credits in the books of the central bank, and the cheques that can be drawn against them are not legal tender; but the credits are counted by the other banks as "cash" and give them the right to demand legal tender from the central bank.
On this foundation of legal tender money and credit at the cen tral bank the other banks (the "commercial banks" as they are sometimes called) build a larger structure of credit by buying securities and making advances to their trade and general cus tomers. Having only been gradually evolved into a central bank, the Bank of England still does a certain amount of business for private customers; but the American Federal Reserve banks, and other central banks set up in the light of modern experience, are usually confined to the task of working for the Government and for the other banks. When a central bank makes advances or buys securities it creates deposits for itself, because whichever of the commercial banks receives the credit so created will add it to its balance at the central bank; but when a commercial bank makes advances or buys securities it creates deposits possibly for itself, if the cheques drawn against the new credit that it makes are handed to its own customers who pay them in to their accounts with it, but more probably for one of its rivals who, however, are at the same time creating deposits for it.